The "Canadian UCITS" set to institutionalise a sub-scale hedge fund sector
A recent trip to Toronto in the heart of winter revealed a number of interesting insights into the $30 billion hedge fund industry in Canada. A country which accounts for 2½ per cent of world GDP ought to be responsible for more than 1½ per cent of the $2.6 trillion invested in hedge fund assets.
An interesting question is why the Canadian industry is so small. The Canadian banks are, by international standards, relatively stable and well capitalised, and almost all of them have investment banking arms – BMO Capital Markets, CIBC World Markets, RBC Capital Markets, Scotiabank, TD Securities and even National Bank of Canada – capable of servicing hedge fund managers.
Institutional investors in Canada, and especially its pension funds, are large and numerous. Several are experienced and sophisticated hedge fund investors. The C$193 billion Canada Pension Plan Investment Board, for example, recently opened an in-house hedge fund in London. The Ontario Teachers’ Pension Plan, which has approximately C$130 billion in assets, has nearly one dollar in ten invested in hedge funds.
However, these sizeable allocators prefer to shop abroad. One manager attributes this to the narrow investment focus of Canadian hedge funds. A Canadian operational due diligence (ODD) executive says a larger obstacle is the inability of domestic managers to “institutionalise.” According to her, Canadian managers fail to separate the duties of the COO and CCO; maintain sub-standard business continuity plans; fail to invest sufficiently in a robust technology infrastructure; and field unimpressive investor relations teams. These shortcomings, say the ODD executive, reflect the fact that many Canadian hedge funds manage money on behalf of high net worth individuals and wealthy families only. They have no need to “institutionalise.”
Another inhibitor to growth in Canada is the stringent concentration limits and binding risk criteria Canadian and non-Canadian institutional investors insist upon. They cannot afford to look at many Canadian managers because the risks are concentrated in Canada.
This could be about to change, according to the Toronto branch of the Alternative Investment Management Association (AIMA). The Canadian Securities Administrators (CSA), an association of provincial and territorial securities markets regulators, is consulting with the hedge fund industry over a Modernisation of Investment Fund Product Regulation (MIFPR). Some observers say it will lead to the mutualisation of Canada’s hedge fund industry.
The MIFPR, which is expected to be implemented from 2015, will allow hedge funds to market beyond the usual caste of “accredited” investors (by which regulators mean individuals with at least C$1million in investable assets) and start managing capital on behalf of retail mutual fund investors. AIMA Canada dubs it “the Canadian UCITS.”
Indeed, rather like their UCITS-issuing counterparts in Europe, Canadian hedge fund managers will probably use bank distribution platforms to take advantage of MIFPR. However, most banks will not let hedge funds running less than C$100 million on to their platforms. That threshold alone will be sufficient to disqualify a majority of Canadian hedge funds from taking part.
Managers that do issue MIFPR funds will be subject to similar compliance requirements as their 1940 Investment Company Act and UCITS cousins in the United States and Europe. The requirements will likely include greater transparency and higher corporate governance standards, and investment and leverage restrictions, though AIMA Canada doubts performance fees will be capped.
Experience elsewhere suggests alternative investment strategies wrapped in regulated vehicles will appeal to institutional as well as retail investors. However, enthusiasm for mutualised hedge fund strategies in the United States and Europe, is often over-egged, and not always driven by what is best for investors (see our Founder’s Letter above) . Nonetheless, for Canadian hedge fund managers running more than C$100 million, it could mark the first step on the long road to “institutionalisation.”